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The Estimation of Risk Premium Implicit in Oil Prices

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  • Jorge Barros Luís
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    Abstract

    Futures prices can be seen as a sum of the expected value of the underlying asset price with a risk premium. In order to disentangle those two components of the futures prices, one can try to model the relationship between spot and futures prices, in order to obtain a closed expression for the risk premium, or to use information from spot and option prices to estimate risk aversion functions. Given the high volatility of the ratios between futures and spot prices, we opted for the latter, estimating risk-neutral and subjective probability density functions, respectively from option and spot prices observed. Looking at the prices of Brent and West Texas Intermediate Light/Sweet Crude Oil options, evidence obtained suggests that the risk premium is typically very low for levels near the futures prices.

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    File URL: http://www.bportugal.pt/en-US/BdP%20Publications%20Research/WP200002.pdf
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    Bibliographic Info

    Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w200002.

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    Date of creation: 2000
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    Handle: RePEc:ptu:wpaper:w200002

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    1. Considine, Timothy J. & Larson, Donald F., 1996. "Uncertainty and the price for crude oil reserves," Policy Research Working Paper Series 1655, The World Bank.
    2. Rosenberg, Joshua V. & Engle, Robert F., 2002. "Empirical pricing kernels," Journal of Financial Economics, Elsevier, Elsevier, vol. 64(3), pages 341-372, June.
    3. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, American Finance Association, vol. 51(5), pages 1611-32, December.
    4. Jens Carsten Jackwerth., 1996. "Recovering Risk Aversion from Option Prices and Realized Returns," Research Program in Finance Working Papers, University of California at Berkeley RPF-265, University of California at Berkeley.
    5. Yacine Ait-Sahalia & Andrew W. Lo, 2000. "Nonparametric Risk Management and Implied Risk Aversion," NBER Working Papers 6130, National Bureau of Economic Research, Inc.
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